When you’ve got friends like this – Part 10

In wishing us all happy new year, Jared Bernstein also pounded his readers with a confused macroeconomic logic, that if applied, would in all likelihood make their new year (collectively) worse. His article (December 29, 2012) – My Views on Spending Cuts and Entitlements – is another one of those cases when friendly fire shoots the progressive movement in the foot. You can read the previous editions of this theme – When you’ve got friends like this – to see what the problem is. In fact, I think I am being rather reasonable in only having this series extend to Part 10 so far. Given what is out there parading as progressive macroeconomic thinking the series might have been much longer than that by now. The simple point is that a truly progressive social agenda has to be grounded in solid macroeconomic principles. Trying to carve out a progressive agenda within a mainstream macroeconomic framework undermines the credibility of the former and plays straight into the hands of the conservatives.

Jared Bernstein – is a Senior Fellow with the – US Center on Budget and Policy Priorities – which says it is:

… one of the nation’s premier policy organizations working at the federal and state levels on fiscal policy and public programs that affect low- and moderate-income families and individuals … we explore are whether federal and state governments are fiscally sound and have sufficient revenue to address critical priorities, both for low-income populations and for the nation as a whole … was founded in 1981 to analyze federal budget priorities …

So the emphasis on the bottom of the income distribution is progressive but the terminology “fiscally sound” and the implication of balanced budget expenditure makes it neo-liberal.

Jared Bernstein’s Wikipedia page says he “is considered to represent a progressive, pro-labor perspective”. It also tells us he studied music then social work but has no “formal training in economics”. He is intrinsically linked to the Obama Administration and has an influential position on the Congressional Budget Office.

On the face of it, a person of that ilk – no formal training in neo-classical economics (good!), the sensitivity of a musician (excellent) and doctoral studies in social work (tends to be progressive) – is required in large numbers in influential economic policy positions.

Unfortunately, along the way it seems he has become an economist (having been “Senior Economist at the Economic Policy Institute”) and now is listed by the CBPP as an “expert in federal fiscal policy”. The problem is that in rising to these lofty levels he doesn’t seem to have simultaneously acquired an understanding of monetary economics and the way governments, central banks and commercial banks actually operate.

He may not have any formal training in mainstream economics but he sure parrots the major narratives that such a training indoctrinates in the students that do undertake such training.

That is the end of the personal elements of the blog. This series – When you’ve got friends like this – is not meant to be a personal attack on anyone. It is designed to point out how progressive people fall into the traps set by the mainstream economics paradigm and end up undermining their own causes – unnecessarily we should add.

In his article – My Views on Spending Cuts and Entitlements – Jared Bernstein says that he wrote his article to help us understand why he (as a progressive) would be “endorsing spending cuts, including some targeted at the social insurance programs Medicare and Social Security”.

He says that the article is a definitive guide to “where I stand”.

First neo-liberal statement – “I’ve also argued that we need to chart a course such that eventually our public debt starts growing less quickly than our GDP”. Please follow the emerging (and excellent) five-part series from colleague Scott Fullwiler – Functional Finance and the Debt Ratio-Part I.

As you will learn, even if the debt ratio mattered, there is no need to pursue fiscal (primary) surpluses in order to stabilise the ratio. As long as the interest rate paid on the government debt is below the growth rate of the economy the debt servicing of any current stock of outstanding debt will not outstript the capacity of the economy to produce real goods and services.

The only issue that Modern Monetary Theory (MMT) economists would consider worthy of discussion is not whether the government faces a solvency problem (which is what Jared Bernstein is worried about) but whether the interest servicing on government debt combined with the other components of government spending are non-inflationary. That requires an analysis of the utilisation rates and growth of productive capacity relative to the growth in aggregate demand.

Second neo-liberal statement (which followed the debt ratio assertion):

In this regard, I’m what you might call a cyclical deficit dove and structural deficit hawk. In downturns, or any period like this with highly elevated unemployment, the most important fiscal question is whether our budget deficits are large and stimulative enough to offset the private sector contraction. In periods of strong growth, the deficit should move toward primary balance, which by definition leads to a decline in the debt/GDP ratio.

First, moving “toward primary balance” does not by definition lead to a decline in the debt/GDP ratio even if real GDP gowth is “strong”. At high real interest rates, the ratio can rise despite growth and thus the statement is false. The correct statement is that it will normally fall.

Second, it is not prudent to take any “position” (dove, hawk) about the deficit. You will note that Jared Bernstein nuances the normal dove position by referring to himself as a cyclical dove and a structural hawk. That nomenclature is, in itself, problematic.

What could it mean? Presumably that he is happy that the cyclical component of the budget – the automatic stabilisers – move into deficit in a downturn. Happy or otherwise, one has no choice in the matter. The cyclical component will always move into deficit when the economy departs from full employment – and that is “by definition” of the term cyclical component.

Regular readers will be familiar with the following but it never hurts to reinforce the knowledge.

The government budget balance is the difference between total revenue and total outlays. Both sides of the books are influenced by two determinants: (a) discretionary government spending and tax policies – which is what economists now call the structural components; and (b) the state of non-government spending – which is what we refer to as the cyclical components.

If total revenue is greater than outlays, the budget is in surplus and vice versa. However, it is obvious that if we decompose the budget balance into components attributable to the two separate determinants then we could get structural and cyclical balances coinciding with a range of actual budget outcomes.

This means that we might wrongly conclude that if the budget is in surplus then the discretionary fiscal impact of government is contractionary (withdrawing net spending) and if the budget is in deficit the discretionary fiscal impact expansionary (adding net spending).

The point is that we cannot conclude – without further investigation – that changes in the fiscal impact reflect discretionary policy changes. The reason for this ambiguity is that the cyclical componet – which we term the automatic stabilisers – also determine the balance.

The most simple model of the budget balance can be written as:

Budget Balance = Revenue – Spending.

Budget Balance = (Tax Revenue + Other Revenue) – (Welfare Payments + Other Spending)

Tax Revenue and Welfare Payments move inversely with respect to each other, with the latter rising when GDP growth falls and the former rises with GDP growth. These are the cyclical components of the budget outcome.

In other words, without any discretionary policy changes, the budget balance will vary over the course of the business cycle. When the economy is weak – tax revenue falls and welfare payments rise and so the budget balance moves towards deficit (or an increasing deficit).

When the economy is stronger – tax revenue rises and welfare payments fall and the budget balance becomes increasingly positive. Automatic stabilisers attenuate the amplitude in the business cycle by expanding the budget in a recession and contracting it in a boom. There is no discretionary component operating.

So to say that one is cyclical dove means that one doesn’t get upset when the cyclical component pushes the deficit in the predictable way. Presumably, the same person does get upset about the unemployment and income losses that are happening in the real economy, which lead to these cyclical effects.

If we understand that then it is also clear that just because the budget goes into deficit or the defiict rises, we are not in a position to conclude that the government has become of an expansionary mind. The opposite is the case when the cyclical components increase government net revenue.

In other words, the presence of automatic stabilisers makes it hard to discern whether the fiscal policy stance (chosen by the government) is contractionary or expansionary at any particular point in time.

This knowledge also confirms that, once the government has made its discretionary budget decisions each year, the final budget balance will be the result of the non-government spending and saving decisions over the course of the year.

If the non-government sector decides to cut its spending growth (or level) then the budget outcome will move towards deficit or to a higher deficit, without the government changing any policy parameters. The automatic stabilisers guarantee that.

An economy which is weakening is predisposed to higher deficits (or lower surpluses) at current (unchanged) policy settings. The opposite is that case in a growing economy.

The automatic stabilisers mean that in a growing economy, tax revenue rises (because it is tied to economic activity via income taxes) and spending is lower (less income support is required).

Which means that governments should only focus on maintaining high rates of economic growth (within general constraints imposed by the need to be environmentally sustainable) and ignore the actual budget balance.

So what could being a “structural hawk” mean? Jared Bernstein implies that it means that if the economy is growing – then the government should seek to tighten the discretionary component of the budget (that is, raise tax rates and/or cut discretionary government spending)? That is, indeed what on balance he advocates or in his words “endorses”.

But would real GDP growth (even strong growth) be a sufficient condition to allow us to conclude that that strategy was responsible and well-founded?

The answer is a resounding no!

No statements can be made about the desirability of a change in discretionary government fiscal policy without refernence to the state of the economy. Growth alone doesn’t summarise the state of the economy.

A progressive “economist” should prioritise the people aspects of the economy and that means ensuring policies can support full employment, which is achieved when everyone who wants to work can find jobs and enough hours available at the current wage rates.

So if there is excess capacity in the economy (and an unemployment queue above the frictional level is testament of that) then there is a need for a larger structural deficit because the state of non-government spending and the automatic stabiliser component that accompanies that spending would clearly be insufficient.

Remember, a basic rule of thumb is that real GDP growth has to be equal to the sum of the underlying productivity and labour force growth for the unemployment rate to remain stable.

So for example, the US Bureau of Labor Statistics tell us that the US unemployment rate at present is 7.7 per cent, labour productivity growth is running at 2.9 per cent and the labour force has been growing on average since 2003 by around per cent 0.7 per annum.

That means that to sustain the unemployment rate at 7.7 per cent (approximately), real GDP growth in the US has to be of the order of 3.6 per cent per annum (or thereabouts – it is a rule of thumb after all). Changes in average weekly working hours can alter this relationship but normally they are not substantial enough to worry about.

If the full employment unemployment rate in the US is say 4 per cent (that is not to be taken as definitive but just a rough ballpark figure to allow the next point to be made) then it would take real GDP growth of 4 per cent per annum sustained over the next 7 odd years to restore “full employment”.

Further, the observed growth is most likely being supported by the structural deficit that the government is running quite apart from the growth support being provided by the automatic stabilisers (the cyclical component).

The fact that the unemployment rate is above the full employment level indicates the cyclical component of the deficit is positive. So any tightening of the discretionary component under those conditions would be “pro-cyclical” that is working with the economic cycle rather than against it.

This raises another issue – that is related to the “dove” position that a budget should be balanced on average over the business cycle. Jared Bernstein tells us that the “deficit should move toward primary balance”.

Why would a progressive maintain that position?

We have already seen that the budget balance is not determined by the government. Its discretionary policy stance certainly is an influence but the final outcome will reflect non-government spending decisions. In other words, the concept of a fiscal rule – where the government can set a desired balance (in the case of the question – zero) and achieve that at all times is fraught.

It is likely that in attempting to achieve a balanced primary budget the government will set its discretionary policy settings counter to the best interests of the economy – either too contractionary or too expansionary.

Further, even when evaluated at full employment – where the cyclical component of the budget will be zero (by definition), it is entirely possible (and likely) that the budget will still be in deficit (given the propensity of the non-government sector to save).

The point is that structural budget balance has to be sufficient to ensure there is full employment. The only sensible reason for accepting the authority of a national government and ceding currency control to such an entity is that it can work for all of us to advance public purpose.

In this context, one of the most important elements of public purpose that the state has to maximise is employment. Once the private sector has made its spending (and saving decisions) based on its expectations of the future, the government has to render those private decisions consistent with the objective of full employment.

So then the national government has a choice – maintain full employment by ensuring there is no spending gap which means that the necessary deficit is defined by this political goal. It will be whatever is required to close the spending gap.

Ultimately, the spending gap is closed by the automatic stabilisers because falling national income ensures that that the leakages (saving, taxation and imports) equal the injections (investment, government spending and exports) so that the sectoral balances hold (being accounting constructs). But at that point, the economy will support lower employment levels and rising unemployment. The budget will also be in deficit – but in this situation, the deficits will be what I call “bad” deficits. Deficits driven by a declining economy and rising unemployment.

So fiscal sustainability requires that the government fills the spending gap with “good” deficits at levels of economic activity consistent with full employment.

Fiscal sustainability cannot be defined independently of full employment. Once the link between full employment and the conduct of fiscal policy is abandoned, we are effectively admitting that we do not want government to take responsibility of full employment (and the equity advantages that accompany that end).

In the current US situation, any policy change by the government that in net terms attempts to shrink the discretionary budget component will undermine growth and move the economy away from the desired progressive goals.

The application of the fiscal policy that Jared Bernstein endorses would undermine production and employment and probably not succeeding in getting the budget into balance anyway.

The reality is very clear in the US. The nation runs a current account deficit. If the government attempts to move towards a balanced primary budget then the direction of policy will be to push the private domestic sectors towards higher deficits (and increased indebtness). The financial crisis was caused by the sort of dynamic.

However, in the current situation, with the debt overhang, flat property markets and high entrenched unemployent, it is highly unlikely that the private domestic sector will be willing to re-engage in the pre-crisis debt binge.

Which means that the government has to continue to run structural deficits if it is to move the economy towards full employment. Whether that is a distateful scenario for the “structural deficit hawks” is bad luck.

What they have to explain to the American people is why they support a policy that deliberately increases or prolongs the high unemployment and increasing poverty rates – in their so-called No 1 nation.

Please read my blogs – Structural deficits – the great con job! and Structural deficits and automatic stabilisers – for more discussion.

Third neo-liberal statement by Jared Bernstein:

I’m also a strong believer in an amply funded government sector that is able to respond to market failures, which guys like me see around many more corners than the typical economist, and structural budget deficits undermine our ability to respond as needed.

That is a lie. It might be true in political terms when we are dealing with failed states as characterised by the US polity. But even then, when things became really grim the US Federal Reserve and Treasury combined to increase spending sharply in a very short time.

The reason that it is a lie is because Jared Bernstein is making a statement about the financial capacity of the US government. As I have noted many times, a currency-issuing government such as the US can buy whatever is for sale in US dollars whenever it chooses, irrespective of its past fiscal position.

A structural deficit today doesn’t preclude a bigger structural deficit tomorrow, just a structural surplus today doesn’t increase the capacity of the government to run deficits of any magnitude tomorrow.

In fact, a structural surplus today almost ensures the government will have to run a deficit “tomorrow” because the fiscal drag will likely undermine growth.

Structural deficits support growth when there is a non-government spending gap – that is it! If the non-government spending gap rises next period, the structural deficit has to rise or else real GDP growth will fall.

Jared Bernstein is invoking the usual mainstream argument that a nation has to live within its means. The idea of “living within ones means” is another of those logical sounding rules that resonate across the conservative world. But what does it mean when a policy environment deliberately forces millions of people onto the unemployment scrap heap with no means and a diminished life.

The means available to an economy can only reasonably be thought of in real terms – that is, the real resources that a nation has available either within its own borders or via trade with other nations.

Living within a nation’s means would require permanent full employment not chronic and significant long-term unemployment. There is some financial sense in the concept of “living within one’s means” when applied to a family or an individual because as users of the currency such spending agents are financially constrained.

Their means relate to the real resources that they can command and that command is limited by their income, capacity to borrow and prior saving.

But for a national government the only sense that can made of that concept is the real resources that the nation as a whole can command.

Implicit in Jared Bernstein’s claim about “ability to respond as needed” is the household-government budget analogy, so loved by the neo-liberals. It is, of-course, flawed at the most elemental level.

A sovereign government is never revenue constrained because it is the monopoly issuer of the currency. It also makes no sense to say that it can “save” that currency (by running surpluses) and thus build up increased capacity to spend in the future.

Conversely, a household uses the currency that the government issues and has to save (forego current consumption) if it wants to expand its future consumption (spending) possibilities, other things equal.

The latter is definitely financially constrained.

Jared Bernstein then proceeded to argue that in terms of expenditure cuts:

… the mandatory side of budget-the part that funds the entitlements-must be on the table as well

That is the fourth neo-liberal statement in the article.

It is clear that the US has a deeply flawed health system dominated by pharmaceutical and private health insurance companies which prey on a population that is not terribly enamoured with healthy living.

It is also true that the outlays by the government on health care have been captured by these private monoliths.

But the neo-liberal leaning of the statement is that the “cuts” are part of an overall fiscal austerity endorsement rather than a progressive policy proposal to introduce a national health care scheme for all Americans and drive the private health insurers and the industry they support out of existence.

Further, these health policy changes would see an expansion of government net spending in other areas of the economy to ensure the non-government spending gap was closed.

There would be no drop in health care standards if that approach was taken and real resources would be distributed more equitably and more effectively.

I agree with him that:

… any cuts should a) come from squeezing out the known inefficiencies from the delivery side of health care system (our current system rewards providers for quantity over quality), b) not target economically vulnerable individuals. As a rule, I’d avoid further raising eligibility ages in both programs.

But the next statement he should have made as a progressive is that the spending savings should be redirected and expanded upon elsewhere in the economy (public education, etc).

None of this proposals indicate he is serious about (a) funding public education to improve health awareness in the US; (b) creating a national health system such as in Australia or the UK; (c) seriously undermining the rents enjoyed by the pharmaceutical companies rather than bargaining “for cheaper drug prices” as the current President is attempting; and (d) destroying the hold that the private insurers have.

They would be a progressive position.


Anyway, it is New Year’s Day and “with friends like that” it is going to be a long year.

That is enough for today!

(c) Copyright 2013 Bill Mitchell. All Rights Reserved.

This Post Has 8 Comments

  1. “The only issue that Modern Monetary Theory (MMT) economists would consider worthy of discussion is not whether the government faces a solvency problem (which is what Jared Bernstein is worried about) but whether the interest servicing on government debt combined with the other components of government spending are non-inflationary.”

    Should we also be concerned with the effect of continual large deficits? A deficit implies that the net financial assets of the non-government sector(s) are increasing. It appears that there is a trickle up process (not trickle down as often claimed) so that the financial assets become concentrated with the wealthy. I would like to see an analysis of the effect of the size of the net financial assets (a stock), especially in comparison to the aggregate level of debt in the private sector and in relation to the distribution of the assets, and whether it should be considered when deciding on the desired level of deficit (a flow) or surplus.

  2. Tony
    Isn’t that a political decision i.e. redistribution of financial wealth?
    i’m not sure that is something MMT would have a view on unless the economy was operating at full capacity.

  3. I wonder, is there really any need at all for a fiat currency issuing Government to ever borrow from the private sector? Why have this absurdity? If the government can mint its own money where is the need to borrow in its own (previously minted) money?

    Also, why does the US have the absurd set-up where the Fed (Reserve Bank) and the Treasury are separate? It seems like a Chinese Wall to allow the pretence that the government cannot mint money. Plus as the Fed is privately owned how is this sensible? To give currency minting power into private hands? Sounds like the height of absurdity to me. And of course a massive private windfall to give that power to private hands.

    * * *

    “The simple point is that a truly progressive social agenda has to be grounded in solid macroeconomic principles. Trying to carve out a progressive agenda within a mainstream macroeconomic framework undermines the credibility of the former and plays straight into the hands of the conservatives.” – Bill.

    Absolutely, 100% correct!

  4. Andy,

    I agree that there is a political/moral component in my question and I think your question is good in that such a thing should be identified explicitly. However, I don’t see why this is necessarily inconsistent with MMT. Don’t the MMTers also include moral elements in their arguments? One such example is the job guarantee.

    There is also a pragmatic component to my question. If wealth is concentrated with the wealthy who have a lower propensity to spend, then that would tend to contract the economy, whereas a more even distribution of wealth would lead to greater economic activity.

    We could ask similar questions about government surpluses, which are regarded by many (non MMTers) as being quite virtuous. But we know that government surpluses, where taxation exceeds spending, extract money from the private sector. Therefore, if people think surpluses are good they must also think that we all have too much money. I doubt if many of such people see the connection though.

    I would not pretend that my comments are comprehensive and I would still like to see a proper analysis of the cumulative effects of deficits and surpluses.

  5. Tony
    Full employment is the main macroeconomic objective of any Government.
    It’s just when Bill says ‘Full employment’, he means ‘Full employment’ and the JG scheme is one of the best ways of achieving that.
    Judgements about individuals’ savings decisions is a completely different kettle of fish, I would suggest.

  6. I read Jared Bernstein quite a lot. He’s a rare progressive economist that a) actually gets some media time in the US and b) isn’t Paul Krugman.

    Clearly, he’s not an MMT guy so the neo-liberal underpinning undermines his arguments, but his rhetoric concerning You’re On Your Own economics vs We’re In This Together (YOYO vs WITT as he regularly refers to it) is excellent. When he gets going on healthcare he’s very good.

    How do we get the message out to progressive economists that should really be on board with MMT?

  7. Ikonoklast, my kudos.. .
    Furthermore, the US Constitution specifically reserves the franking right to the Congress, that is the
    right to print and coin money in the USA is by constitutional section reserved to the Congress (House & Senate). No where in that section, is mentioned the authority to delegate this function to a private entity such as the Federal Reserve.
    The traditional congressionally mandated bureau of the executive branch tasked with printing money is the Bureau of Engraving and Printing, and the bureau tasked with coinage is the Bureau of the Mint. Both are agencies of the Treasury Department. It would seem to me that both these should report to the Comptroller of the Currency, currently an independent agency within the Treasury Department. In today’s fiat electronic currency regime, it would appear that another bureau is required, the Bureau of Electronic Currency, also to report to the Comptroller of the Currency (OCC). The Bureau of Electronic Money, would be tasked with maintaining accounts with the various branches of government, Federal, State, and Local, as well as with the Federal Reserve, for the purpose of funding them, as directed by the
    OCC. The OCC, which currently is responsible for supervising National and Foreign banks which do business within the US, which administers the Deposit Insurance Scheme and anti money laundering regulations, has 4 regional and 48 state offices nationwide. It reports directly to Congress, so the fit is a natural one. Thus my proposal is that the OCC be further tasked with gathering statistics on the current account, level of debt at all levels of govt, and in the civilian sector, u-6 unemployment(the broadest measure), for the purpose of determining the level of deficit required to bring the economy to full employment. Further the BEM could open accounts for each of the 50 Federally Chartered State Banks, that is owned by the government of each of the 50 states, and each of the 24 Federally Chartered development banks, such as the Export Import Bank, Agricultural Credit Bank, Industrial Credit Bank, Renewable Energy Bank, Fossil Energy Bank, Utility Credit Bank, Federal Investment Bank, Federal Housing Bank, Fannie Mae, Freddy Mac, Transportation System Bank, Infrastructure Development Bank, etc. This scheme would obviate the need for bond issues for water, sewer, and other local infrastructure.

    It is my view, from a US Constitutional standpoint, that the US Federal Reserve can remain lender of last resort to it’s member banks, provided the Comptroller of the Currency acts as lender of last resort to the Federal Reserve, providing coin, bills, and electronic credits to the Fed’s account with the Comptroller’s Office. This would engender debt on the part of the Fed, with the Comptroller’s Office being the lender, entitled to interest at rates set, by the Comptroller, not by the Fed. It would be expected that the Fed would markup these funds to higher interest rate(s), when lending them to it’s member banks, and would life off the differential.

    Similarly, the Comptroller’s Office would provide an account to Treasury, into which it would credit funds necessary to cover anticipated deficit(s) less bond issuances. Furthermore, the OCC could make periodic reports to Congress, regarding the sectorial balances, dynamics in the civilian and governmental debt stocks and flows, the current account, and the level of deficit required to promote full employment. The OCC could also advise Congress regarding programs such as National Service for Youth, and JG, regarding the impact of such programs on promoting full employment on the deficit required to keep demand at the full employment level.


  8. “Full employment is the main macroeconomic objective of any Government.”

    I do not disagree with this statement. The only real question remains, namely whether this is achieved by central planing or by a free economy (within the limits of the rule of law).

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